Monday, March 17, 2008

Like Hamlet, we often face tough decisions without perfect information. In Hamlet’s case, the choice was something like, “My dad was murdered. I think my uncle did it. Now he’s my stepdad. Sigh.” What’s a prince to do? Should he seek revenge? Should he rat out his uncle? Seemingly incapable of making a decision, Hamlet stuck with the default: do nothing and stew.

Maybe Hamlet had the right idea. According to Ofer H. Azar, a lecturer in the School of Management at Ben-Gurion University of the Negev in Israel, inaction may often be a prudent choice in situations where most of us feel compelled to do something.

Mr. Azar studied high-stakes decision-making—not in the boardroom, but on the soccer field, where he collected data on the attempts of professional goalies to block penalty kicks. Regularly faced with huge incentives to block penalty kicks, goalies offer a great proxy for people who routinely make quick, high-pressure decisions. Mr. Azar hoped to see just how rationally people respond to such situations. Surprisingly, he found that goalies facing penalty kicks tended to let their emotions dictate their actions—often leading to detrimental outcomes.

During a penalty kick, the goalie must stand with his heels on the goal line while an opponent kicks the ball from 12 yards away. The goalie cannot move until the opponent has kicked the ball, and there is not enough time for the goalie to watch the shot and react. Thus, goalies must make a choice about where they think the ball will be kicked before the shot is made.

Since the greatest proportion of shots end up near the center of the net, the goalie’s best defense is to stay put. The trouble is, goalies find it very difficult to stay in the middle, simply because it makes them feel they aren’t doing anything. When asked why they jump left or right when it's efficient to stay put, they explain that they would feel worse if they stayed in the middle and the shooter scored than if they had at least jumped one way or the other.

We are not all professional soccer goalies. But we may feel the compulsion to act under pressure. Even if inaction is more efficient, we may take action just so we feel good about doing something. Emotion can play a large part in our decisions, especially high-stakes decisions. Economists may need to reassess the degree to which emotions can influence decision-making. In the same article, Stanford economist Paul Romer says, “How people feel about various kinds of activities means a lot about what they decide to do. In many situations, [economists] just look at the narrow monetary payoffs and forget about the effects of preference or feelings.” To learn more about the blend of emotion and calculation that goes into our decisions, read this article from the New York Times and think about the questions below.

Discussion Questions

1. Apply this logic to high-stakes business decisions made by major corporations. When times are tough, do companies tend to want to do something rather than ride out the storm? Is that always the right decision?

2. What about playing the stock market? How much do emotions play a part in the decisions we make?

3. Identify areas in your own life where emotion plays a part in important decisions. Would the outcomes of your decisions be better if emotion did not play a part?

Monday, March 10, 2008

The government's monthly survey of businesses indicates that payrolls experienced a net drop of 63,000 jobs during February. At the same time, numbers from the government's monthly survey of households indicated that the unemployment rate declined from 4.9% in January to 4.8% in February. How can the unemployment rate fall even as the economy sheds jobs? Understanding this paradox requires a closer look at the household survey numbers for the past two months.

* Numbers in thousands

The household survey indicates that the number of employed persons saw a net decline between January and February. The ranks of the employed thinned by about 255,000 people. Normally, the net drop in the number of employed people would cause the ranks of the unemployed to swell by a similar amount. The government considers a person unemployed if she lacks a job but has actively searched for one in the past four weeks. Yet, the pool of unemployed workers actually shrank by about 195,000 people between January and February. The change in the size of the labor force over the same period provides some clues as to why.

The number of people dropping out of the labor force in February exceeded the number of new entrants—on net about 450,000 people left the labor force. These people either left jobs with no intent of finding another or gave up on their employment searches altogether. If you want a job but you're so frustrated with past failures to find one that you stop looking, the government classifies you as a discouraged worker and no longer considers you to be part of the labor force.

All things being equal, February's employment drop of 255,000 should have increased the pool of unemployed workers from 7.58 million to 7.83 million. Things weren't equal though, as a number of people considered unemployed in January gave up on their job searches in February, contributing to the 450,000 person drop in the size of the labor force and causing the number of unemployed workers to come in at 7.38 million in February rather than 7.58 million. If we assume that all 450,000 people became discouraged workers in February, the drop in the ranks of the unemployed and, consequently, the labor force, reflects the inability of those out of work to find compatible job vacancies.

The unemployment rate is simply the ratio of unemployed people to the size of the labor force (unemployed / labor force). Since the ranks of the unemployed declined by 2.6% and the size of the labor force declined by only 0.3%, the fraction of the labor force considered unemployed declined from 4.9% in January (7,576 / 153,824) to 4.8% in February (7,381 / 153,374). In this peculiar case, the small drop in the unemployment rate reflects economic weakness rather than economic strength.

Discussion Questions

1. Here's what the employment numbers for February would have looked liked if the 450,000 people who left the labor force had remained in the labor force as jobless workers actively searching for employment (unemployed people):

* Numbers in thousands

Under these conditions, what would the unemployment rate have been for the month of February 2008?

2. You can find the Bureau of Labor Statistic's (BLS) news release for February 2008 here. The national unemployment rate is at best a rough gauge of joblessness in the United States. The February numbers illustrate how the unemployment rate can paint a misleading picture of labor market strength. A fuller understanding of labor market issues requires a closer look at employment figures. How do the unemployment rates for specific age and racial groups differ from the national rate?

3. According to the BLS, who are the people who “work part time for economic reasons”? What has happened to their numbers over the past year? Does the unemployment rate capture changes in the number of folks who work part time for economic reasons?

4. Our assumption that all 450,000 people who left the labor force in February became discouraged workers is unrealistic. (Indeed, the BLS only counted a total of 396,000 discouraged workers in February.) Who, according to the BLS news release, is considered a “marginally attached worker”? Are all marginally attached workers also discouraged workers?

5. An unemployment rate of just below 5% is still relatively low by historical standards. Nonetheless, tepid employment reports in January and February darken the U.S. economic outlook when considered along side reports of weak output growth and continuing turmoil in housing and financial markets. Keeping in mind that the Fed's recent rate cuts and the government's tax rebates will begin to impact the economy in May and June, what type of economic performance do you expect in the United States for 2008?